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Free Markets and Poverty

For better than two decades, the orthodox recipe for
global growth has been
embodied in the so-called Washington Consensus. This approach, advocated by the
United States and enforced by the World Bank and the International Monetary Fund
(IMF), holds that growth is maximized when barriers to the free flow of capital
and commerce are dismantled and when individual economies are exposed to the
discipline, consumer markets, and entrepreneurs of the world economic system.
Proponents of this view have contended that the free-market approach to
development will also alleviate poverty, both by raising overall growth rates and
by bringing modern capitalism to the world's poorest.

Yet the actual experience since 1980 contradicts almost every one of these
claims. Indeed, the free-trade/free-capital formula has led to slower growth and
more vulnerability for poor countries--and to greater income disparity among
individuals. In 1980 median income in the richest 10 percent of countries was 77
times greater than in the poorest 10 percent; by 1999 that gap had grown to 122
times. Progress in poverty reduction has been limited and geographically
isolated. The number of poor people rose from 1987 to 1998; in many countries,
the share of poor people increased (in 1998 close to half the population in many
parts of the world were considered poor). In 1980 the world's poorest 10 percent,
or 400 million people, lived on the equivalent of 72 cents a day or less. The
same number of people had 79 cents per day in 1990 and 78 cents in 1999. The
income of the world's poorest did not even keep up with inflation.

Why has the laissez-faire approach worsened both world growth and world income
distribution? First, the IMF and the World Bank often commend austerity as an
economic cure-all in order to reassure foreign investors of a sound fiscal and
business climate--but austerity, not surprisingly, leads to slow growth. Second,
slow growth itself can mean widening income inequality, since high growth and
tight labor markets are what increase the bargaining power of the poor.
(Economists estimate that poverty increases by 2 percent for every 1 percent of
decline in growth.) Third, the hands-off approach to global development
encourages foreign capital to seek regions and countries that offer the cheapest
production costs--so even low-income countries must worry that some other, even
more desperate workforce will do the same work for a lower wage. Finally, small
and newly opened economies in the global free market are vulnerable to investment
fads and speculative pressures from foreign investors--factors that result in
instability and often overwhelm the putative benefits of greater openness. All of
these upheavals disproportionately harm the poorest.

Capital and Trade

Because capital controls were reduced or eliminated
virtually everywhere over the past 20 years, the flow of capital to developing
countries increased rapidly, from $1.9 billion in 1980 to $120.3 billion in 1997
(the last year before the global financial crisis). Even in 1998, in the wake of
financial crisis, the flow of capital remained remarkably high at $56 billion
(although a substantial share of this money consisted of short-term portfolio
investments).

Unfortunately, faster capital mobility in a deregulated environment means an
increase in speculative financing and, thus, greater financial instability. Under
such conditions, the poor are unlikely to escape poverty through economic growth
because they are ill equipped to weather the macroeconomic shocks.

Moreover, higher-income people can protect themselves more effectively from
the fallout of a crisis. They have capital that they can move overseas. At the
same time, in the IMF/World Bank formula, a crisis invariably calls for a
reduction in public spending--at precisely a moment when the poor are more
dependent on social safety nets. So on both counts, laissez-faire widens the gap
between rich and poor.

Trade liberalization--the complement to deregulated capital markets in the
global deregulation agenda--also plays a significant role in expanding inequality
and limiting efforts to reduce poverty. It induces rapid structural change as
well as a decline in real wages, working conditions, and living standards. It
also gives teeth to employers' threats to close plants or to relocate or
"outsource" production abroad, where labor regulations are less stringent and
more difficult to enforce--thus undermining workers' attempts to organize and
bargain for improved wages and working conditions. This trend fuels a race to the
bottom in which governments vie for needed international investment by
scrambling to offer employers the cheapest body of laborers.

The connection between rapid trade liberalization and inequality is reflected
in downward wage pressures and rising inequality in industrializing as well as
industrialized economies. A 1997 report by the United Nations Conference on Trade
and Development, for instance, found that trade liberalization in Latin America
led to widening wage gaps, falling real wages for unskilled workers (often more
than 90 percent of the labor force in developing countries), and rising
unemployment.

Evidence is overwhelming that income inequality is rising in
industrializing countries. But there is also a broad consensus--even among
laissez-faire cheerleaders--that income inequality has risen in developed nations
as well since 1980. In a 1997 paper for the Journal of Economic Literature,Peter Gottschalk and Timothy M. Smeeding found that "almost all industrial
economies experienced some increase in wage inequality among prime-aged males" in
the 1980s and early 1990s. Further, data from the widely respected Luxembourg
Income Study show that among 24 such countries, 18 experienced a rise in income
inequality, only 5 experienced a decline in inequality (Denmark, Luxembourg, the
Netherlands, Spain, and Switzerland), and 1 (France) saw no change.

While a widening gap between the rich and the poor within countries is not
universal, it appears to have occurred in most countries and is affecting most of
the world's population.

Problematic Poster Children

The World Bank's conclusion that the lot of the poor has
improved during the era of increasing trade- and capital-liberalization relies
substantially on data from China and India. But both countries are anomalies. In
reality, the facts in India and China undermine the case for a connection between
greater deregulation and falling poverty and inequality. While in China the
percentage who are poor has fallen, there has nonetheless been a rapid rise in
inequality--most notably, from 1985 to 1995, between rural and urban areas and
between provinces with urban centers and those without them. Also, a large number
of China's workers labor under abhorrent, and possibly worsening, slave- or
prison-labor conditions. This not only means that many workers are left out of
China's economic growth; it also makes China an unappealing development model for
the rest of the world. Thus, improvements in China are not universally shared and
leave many workers behind, often in deplorable conditions.

Using India to illustrate the benefits of unregulated globalization is
equally problematic, since the country achieved its progress while remaining
relatively closed off to the global economy. Total "goods trade" (exports plus
imports) was about 20 percent of India's gross domestic product in 1998, or 10
percentage points less than in China and only about one-fifth the level of such
export-oriented countries as Korea. Moreover, the IMF views India as something of
a laggard in deregulating its economy. IMF reports regularly recommend further
liberalization of India's trade and capital flows--the only large developing
economy for which this is the case.

More broadly, to use India and China as poster children for the IMF/World Bank
brand of liberalization is laughable. Both nations have sheltered their
currencies from global speculative pressures (a serious sin, according to the
IMF). Both have been highly protectionist (India has been a leader of the bloc of
developing nations resisting WTO pressures for laissez-faire openness). And both
have relied heavily on state-led development and have opened to foreign capital
only with negotiated conditions. The Heritage Foundation, in its annual Index
of Economic Freedom, ranks India and China as tied for spot 121--among the
least economically open nations in the world. Yet by letting in foreign capital
in a limited and negotiated way, India and China have benefited from investment
without totally sacrificing economic sovereignty. There may be a larger lesson
here.

A Broader Perspective

The World Bank's assertion that "between countries,
globalization is mostly reducing inequality" seems to contradict the IMF's
assessment that "the relative gap between the richest and the poorest countries
has continued to widen" in the 1990s. Given this confusion, it is useful to take
a global perspective that looks at the distribution of world income across all
countries and across all people.

Distribution among countries unambiguously worsened in the 1980s and 1990s.
In other words, rich nations have gotten richer and poor ones have gotten poorer.
The median per capita income of the world's richest 10 percent of countries was
77 times that of the poorest 10 percent in 1980, 120 times greater in 1990, and
122 times greater in 1999. The ratio of the average per capita incomes shows an
even more dramatic increase.

World-income distribution across people (rather than countries) witnessed
equitable improvement to some extent in the late 1990s, after a dramatic rise in
inequality during the previous years. While the richest 10 percent of the world's
population had, on average, incomes that were 79 times higher than those of the
poorest 10 percent in 1980, their incomes were 120 times higher in 1990. That
ratio dropped to 118 in 1999. The improvement in equality was somewhat more
pronounced in terms of median incomes; yet even under this measure, income
distribution was remarkably less equitable in 1999 than in 1980.

The few gains in the 1990s come solely from rising incomes in China. If China
is excluded, there is an unambiguous trend toward growing income inequality
across the remaining world population in the 1980s and 1990s. But since income
distribution in the People's Republic has become substantially less equitable in
the 1990s, the inclusion of China's per capita GDP in the distribution of world
income across all people exaggerates improvements in the world's income
distribution in the 1990s. Put simply, inequality is a bigger problem at the end
of the nearly 20-year experiment with unregulated global capitalism than it was
before deregulation became the rule.

Despite official claims to the contrary, the evidence clearly shows that the
laissez-faire era has been one of slower growth and greater inequality. And the
apparent improvement of that trend in the 1990s is the result solely of rising
per capita income in China, where the enormous population tends to distort world
averages. Even so, income inequality within countries is also growing. Success in
reducing poverty has been limited.

The promises of more-equal income distribution and reduced poverty around the
world have failed to materialize under the current form of unregulated
globalization. It is time for multinational institutions and other international
policy makers to develop a different set of strategies and programs to provide
real benefits to the poor.